Innovation: A Gift or a Curse? Industry and Company Analysis of Apple

The following guest post from fellow financial analyst warrior Dara Alami showcases an application of how industry and company analysis can be performed to provide insights on a firm’s future prospects. This is directly related to Study Session 14 of the CFA Level 1 curriculum and demonstrates how the theory can be applied in the real world.

The company being analyzed here is Apple Inc., one of the most popular and widely held company in both retail and institutional portfolios. As such, it is helpful to perform an industry and company analysis of Apple in order to see its investment merits. The following chart shows the phenomenal ascent and the recent turmoil experienced by this iconic firm.

Innovation: A Gift or a Curse?

An analysis of Apple

by Dara Alami

Going from the verge of bankruptcy to the most profitable company in its industry, in 2012, Apple Inc. was said to be the “most valuable company in the world”. This “value” that made Apple Inc. what it is today can be directly attributed to its genius creator, founder, and previous CEO Steve Jobs. He was a visionary who revolutionized the way people perceived technology. Yet his influence reached far beyond that. Through his innovations at Apple, Jobs was able to change the future of entire industries, ranging from software and hardware to music, publishing and communication. In 2007, Jobs’ focus on innovation and design built primarily around the consumer’s convenience was one of the main strategies he used to rebuild the Apple empire back from ruins. Apple became the leader in the industry with innovative products such as the Ipod, Iphone and Ipad at a time where competitors fell behind in an attempt to catch up to this rising giant. Apple’s leadership strategy was mainly based on both innovation and differentiation. Unfortunately, these strategies may not be as sustainable as they seem.

The following analysis will demonstrate that Apple’s unprecedented success in the field of technological innovation cannot fuel above-average profits (followed by high stock prices and increasing market share) if the company does not remain a leader and the first to introduce differentiated and innovative product. In addition, Tim Cook is facing a challenge that requires him to pay more attention to cost leadership in an attempt to pre-empt any potential losses in case of setbacks in innovation that may occur as a result of the high degree of competition in the industry.

The External Environment

The external environment creates both opportunities and threats for companies, and an understanding of the external environment is vital to the very survival of the firm. This is because a firm’s strategy is directly influenced by its external environment. Apple’s external environment can be divided into macroeconomic, technological, demographic and social factors. The economic factors that can be seen as opportunities in the technological industry are the need for lower cost products that satisfy the consumers’ needs in the midst of a declining global economy. Socio-cultural trends include the move towards “smarter” and more portable devices that have a slick design and are more user-friendly. As for technological trends, there is a constant need for innovation and to be at the fore front of technological advances. As will be explained later, Apple did not follow the technological trend, it lead it.

Porter argues that there are five forces that shape the industry: bargaining power of buyers, bargaining power of suppliers, threat of new entrants, threat of substitute products or services, and intensity of rivalry. In the technology industry the bargaining power of buyers is high in the long-run since consumers can always “switch” to a rival device. In this industry, switching is a cost free concept which means that consumers can switch to alternative products at little to no costs. This factor makes the differentiation of products a necessary strategy that eliminates the risk of buyers bargaining power. When a product is differentiated, it is less susceptible to loss of sales as a result of any price premiums. This is because differentiation builds customer loyalty and customer loyalty makes products less sensitive to price changes. These factors are contributed largely to Apple’s differentiation strategy during the Jobs era.

The bargaining power of suppliers is another factor than can affect a firm’s strategy and that has affected the way Apple viewed its suppliers. The strategies that Apples implemented however, as will be explained later, reduced suppliers’ bargaining power and helped limit the cost of its products when faced with economic turmoil and increasingly demanding consumers. Finally, despite the innovative and leadership status of Apple, the company failed to set the proper barriers to eliminate the threat of new entrants in the industry and limit the availability of substitutes for similar products at a much lower price. Apples’ strategy towards its competitors has varied over the years. Yet, the company’s strategic group position amidst other technology giants such as Samsung and HP will not be sustained if Apple does not alter its strategy in the near future.

Internal Analysis: the Value Chain

Creating value was the ultimate goal for Steve Jobs, a strategy that was behind his innovative success. This value, which Jobs brought to Apple, is based on multiple unique core competencies that were an integral part of its value chain.

The primary activities for apple are: operations, marketing and sales, R&D, and human resources. For most companies, R&D would be classified as support activity, but for apple, R&D was a driving force. Apple’s support activities include: customer service, supply chain management (inbound and outbound logistics), and design. Apple’s supply chain is one of the most efficient and well designed supply chains in the world. Its ability to get the product to the public “at the right time” and without incurring unnecessary inventory costs has put the company at an advantage among its competitors. Furthermore Apple’s unique design activities base on “ease of use” and technical elegance tailored to the consumers’ needs has brought about the above average returns that the company has witnessed through the years.

One of the biggest strengths at Apple was Steve jobs focus on R&D. Even though R&D meant higher costs for Apple, it also meant the beginning of a new era of technological innovations that would lead the company into new markets such as the communication market and the music industry.

Marketing and sales activities also added value to Apple’s value chain by selling a “way of life” rather than a product. The iPhone’s marketing strategy brought this piece of technology the attention it deserved and was a driving force behind its success.

These factors played a huge role in developing Apple’s core competencies that are based on both capabilities and resources: “designing its own products from scratch”, using unique and simple designs that are “user friendly”, a team of talented engineers and product designers, an excellent distribution system based on national chains, focused product lines, and most importantly an excellent and well financed R&D department. After all, in such a volatile industry, R&D is the lifeblood of a company and Steve jobs realized that cutting costs on this core competency would result in a death sentence for Apple.

Apple’s Strategy

During the Scully years, the Macintosh was the main focus of Apple. His strategy in a competitive market dominated by giants like IBM, HP, and Dell, was differentiation. Apple created a Mac that allowed its customer to “Plug and Play”. By designing the Mac from scratch, using unique chips, disk drives and monitors, Scully was able to collect a set of loyal customers who were insensitive to the product’s premium price until IBM prices dropped, making the Mac overpriced and replaceable. That’s when Scully decided to move towards a lower cost product and appeal to the masses by making what he mistakenly thought a good alliance with his main rival; IBM. After Scully’s failure to turn Apple’s sales around, Spindler and Amerlio decided that cost leadership/differentiation strategy is vital. Yet they failed at truly differentiating their products from their leading rivals. (Yoffie, 2012)

In 1997 Jobs took a whole different approach for Apple. He saw that opportunity lied in differentiation rather than cost leadership. Jobs also saw an chance to diversify Apple’s products offering and create economies of scope through innovation. Perhaps one of his most crucial strategies was the expansion of Apple to the global market. This allowed Apple to capture a larger market share in countries with emerging trends of technological innovation.

Jobs also adopted a more focused strategy where a few products would be the center of attention and slashed the rest of the products that he believed had no potential. Internally Jobs believed that innovation was key to the very survival of his company. This is why he needed to be the leader in the industry in every step of the game. While the industry growth was driven by lower prices and expanding capabilities, Jobs had no choice but to make his products as differentiated and innovative as possible by focusing on the design of the product. And so he did; in 2007, Jobs introduced the revolutionary iPod that allowed people to store up to 10,000 songs in one device. He complemented this product with the iTunes, which he made compatible with any of his competitors software, a strategy that would prove to be a successful one. He later introduced the world to the iPhone, in an industry Apple knew nothing about. This diversification strategy made Apple the largest company in the world. With the App Store offering more applications than any other competitor, Apple was able to lock its iPhone sales and crush rivals who attempted to replicate this strategy. The App Store was another “first” for Apple that allowed users to download applications straight to their phone. Jobs was not satisfied however. New socio-cultural and economic factors provided Jobs with an opportunity to capitalize on the emerging trend of tablets and the economic downturn which brought the need for lower priced products that can bring similar benefits as that of the Mac but in a device that cost less and was easier to carry: The iPad. (Yoffie, 2012)

Jobs diversification strategy did not stop there, he went to create the “bookstore” which in turn began to dominate the publishing industry. Even though this was a new industry to tap into, the “bookstore” was able to compete against one of the industry’s leading giants, Amazon. The bookstore was not the iPad’s biggest attribute however. Jobs’ approach to the iPad was different than his other innovations. Jobs began to realize the importance of Cost leadership in the industry and thus decided to increase its gross margin to 25% (compare to 15% in the industry) by using internally developed CPUs. The final and latest notable innovation for apple was the iCloud, which allowed apple clients to sync all of its products using a virtual network called a cloud. The introduction of the cloud reinforced a new differentiation strategy than no rivalry has used. It made switching to substitutes that much harder for consumers because no other company offered such a convenient and easy to use service. (Yoffie, 2012)

What is next for Apple?

During the early stages of the company, Apple was the drive behind the changes in the technology industry. In 1978, the Apple II “sparked a revolution” that made the PC industry a multi-billion dollar industry. (Yoffie and Rossano, 2012). During these stages, Apple was able to change the external environment rather than use it to its own advantage. It was not until 2007 that Apple turned the tables and began to capitalize on the technological opportunities present in this industry.

The tech industry is extremely volatile. Companies in this sector need to not only adapt to their environment to become the leader, they must change the external environment to their advantage. This is exactly what Apple was able to do. Steve Jobs imagined a future and took the initiative to change the entire industry in that direction. Even though emerging trends in the technological world drove other firms’ strategies, Apple was the leader of its own technology world. Socio-cultural factors such as people’s need for faster, more “on the go” products and other economic factors such as the financial crisis of 2008 drove the market towards cheaper and more portable products. These phenomenon lead to the creation of the iPad and were the reasons behind its huge success. However, Jobs was able to change and drive the external environment through his strategies rather than the opposite. Jobs’ focus on innovative, slick, and fashionable designs changed socio-cultural factors rather than capture them. While the Mac products introduced new uses for computers, the iPhone, and the iPad’s design created a culture that was more aware of the importance of design and appearance, even in the field of technology.

Apple did not take the external environment and twist it to its advantage but rather created a whole new external environment on which a new industry was founded. Steve Jobs was the man behind this phenomenon, a man who did not want to give people what they wanted, but wanted to give them innovations they don’t even know they want yet.

In order for Apple to remain ahead of the game however, it needs to be able to use its core competencies to be both a cost and differentiation leader in this increasingly cost sensitive world. Furthermore, Apple should focus on new strategies to block any new entry to the market and hamper current rivals who are up to speed on every innovation. Apple’s innovative and differentiated strategy has turned the company into an industry leader, it did not however stop competitors from coming up with similar products that offer similar value added services at a lower cost. Apple’s differentiation strategy might have kept its loyal customers insensitive to premium prices, it will not however be a sustainable and long lived strategy if it is outperformed at any point in time by a competitor.

Written by Dara Alami

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